Purchase order (PO) financing is a type of creditor advance that businesses use to pay their suppliers for goods that they resell or distribute. With typical monthly rates ranging from 1% to 6%, businesses can finance up to 90% of purchase order costs. Purchase order financing may be a viable option for fulfilling a new customer order if sales exceed incoming cash flow.
A purchase order is a commercial document issued by a company when it places an order with one of its vendors or suppliers. The document includes information about the goods to be purchased, such as the type, quantity, and prices. Simply put, it is the contract that the buyer prepares when purchasing goods from the seller.
How does PO financing work?
Purchase order financing involves a minimum of four parties at different points in the process:
- Borrower: This is the business seeking financing.
- Purchase order financing company: This is the company providing financing. The PO financing company evaluates the purchase order and provides funding to the supplier.
- Supplier: The supplier is the company providing the goods that the borrower resells or distributes. The supplier receives payment for the goods directly from the purchase order financing company.
- Customer: This is the borrower’s customer and the ultimate recipient of the order. When purchase order financing is utilized, customers can either make payments to the borrower of the PO financing company.
Because there are so many parties involved, completing the financing process while keeping costs low can be more difficult. For example, if your suppliers take too long to produce goods, your costs will rise. Because rates are charged monthly or even daily, the longer it takes for the PO financing company to get paid, the more expensive the funding.
The PO financing process begins when the borrower receives a purchase order from its customer. The borrower then makes a requisition request from its own supplier to determine the cost of the transaction. Without sufficient working capital and armed with the purchase order and commercial invoice from its supplier, the borrower turns to a PO financing company for capital to complete the transaction. The finance company pays the supplier, and the goods eventually reach the customer further down the supply chain. The borrower repays the PO financing company at the maturity date.
Purchase order financing is an excellent source of capital for supply chain businesses that are experiencing cash flow shortages and are unable to fulfill customer orders. It is quick, cost-effective, and can be used by a wide range of businesses throughout the supply chain. The financing facility is used by manufacturers to purchase bulk raw materials from their suppliers; distributors to buy goods wholesale from manufacturers, and retail stores to buy from distributors.
Benefits of Purchase Order Financing
- It is ideal for supply chain companies that have a growing customer base but lack the capital to fulfill outstanding customer orders.
- Purchase Order financing provides funding based on the transaction’s terms (commercial invoice, purchase order, insurance certificate, etc.) Because it is not a loan, no collateral is required, and there is no debt on the company’s balance sheet.
- When compared to obtaining a bank loan, applying for and receiving financing is relatively quick and simple because the transaction is judged on its merits rather than the borrower’s credit rating.
